Unpledging Allegiance: Giving up your Passport to Save on Taxes

Eduardo Saverin, a billionaire co-founder of Facebook, made headlines this year when he renounced his U.S. citizenship and became a Singapore citizen. Then New York socialite Denise Rich attracted considerable attention after she gave up her citizenship in favor of Austria. Both were seen as motivated by the potential of saving a fortune in taxes.

Whether you are outraged by their moves or applaud Saverin and Rich's savvy, the reality is that the decision to give up American citizenship is a fast-growing trend. While the totals are still relatively low, the number of Americans who relinquished their citizenship last year (about 1,800) increased almost eightfold since 2008, according to the Internal Revenue Service.

SELF-IMPOSED EXILE?

If one of your clients is considering giving up citizenship, there are a number of factors on both sides of the ledger that should be considered:

* In many countries, you are not taxed unless you are residing in your homeland. In the United States, it doesn't matter where you live or how long you have been living there. You still have to pay U.S. taxes if you continue to be an American citizen.

* For Americans with foreign investments or those who live outside the United States, offshore compliance has become more complex and costly as a result of the Foreign Account Tax Compliance Act and the Report of Foreign Bank and Financial Accounts, among other filings. Failing to properly file carries the potential of significant penalties and criminal sanctions.

* One notable aspect of the Foreign Account Tax Compliance Act is that the U.S. government has imposed reporting obligations not just on American taxpayers, but also on foreign institutions that deal with them. Consequently, Americans living abroad are having a much more difficult time establishing even basic banking and investment relationships.

* If a client is considering giving up his or her passport to save money, a hefty exit tax might come due. In general, anyone with a net worth in excess of $2 million will be subject to capital gains taxes. For those with assets with a low cost basis, like Saverin, the exit tax may be substantial. For those with high basis assets or investments currently in the red, there may be no exit tax at all.

* The federal capital gains rate is now 15%, but it's scheduled to increase to 20% in 2013. In addition, there is now an estate- and gift-tax exemption of $5.12 million with a lowered 35% estate- and gift-tax rate, but unless lawmakers intervene, the exemption will drop to $1 million, and the tax rate will climb to 55% in 2013.

As they assess the pros and cons, clients need to know that a decision to renounce is permanent. Americans who do so also must accept that their travel back to the U.S. will be subject to restrictions. For some, that may be too high a price to pay.

Jim Duggan is a founding principal of Duggan Bertsch, a tax, estate and wealth planning firm in Chicago.